10 Creative (But Legal) Tax Deductions

You love growing vegetables. You love growing vegetables so much that you sell your extra produce at the local farmer's market. But when you add up the money you invest each year in seeds and fertilizer and equipment repairs, you realize that this is becoming an expensive hobby. The problem is that the Internal Revenue Service (IRS) doesn't allow you to deduct expenses related to hobbies. Instead of scaling back your garden, however, why not turn your passion into a small business?

You don't have to jump through a bunch of legal hoops to start a small business. If you're a sole proprietor, you simply report your business income and expenses on Schedule C of your normal 1040 tax return. The perk is that you can deduct all of the "ordinary and necessary" expenses related to your business, even if you don't make a profit. Seeds, fertilizer and farmer's market signs are all ordinary and necessary expenses for a market gardener.

But here's where things get tricky. Whether or not your small business is profitable, the IRS insists that there be a "reasonable expectation of earning a profit" [source: Pagliarini]. If you claim business losses year after year, the IRS might question whether this hobby-turned-business is really just a tax shelter. The best way to prove your legitimacy is to pass something called the "three of five" test [source: Nolo]. If your business was profitable in at least three out of the past five years, the IRS should leave you alone.